Franco Nevada Remains On Track
On Wednesday afternoon Franco Nevada Corp. (NYSE:FNV) announced its fourth-quarter and year-end results for 2013. The company took a couple of hits this quarter and for the full year, but overall it reported a solid number that confirms management will continue to deliver the exceptional growth and high operating margins that investors have come to expect.
First, let us look at the bad news. During the fourth quarter Franco Nevada took a $108 million impairment charge on is McCreedy precious metals stream as KGHM International ceased production at this mine. The company also took a $24 million impairment charge on its stake on the Falcondo ferronickel project (operated by Glencore Xstrata) in the Dominican Republic. We also saw the company’s revenue take a hit as a result of lower gold and platinum prices. For the quarter, the company’s average realized gold price fell by 26 percent year over year, and its average realized platinum price fell by 13 percent year over year.
But other than these hiccups everything seems to be in order for this gold-bug favorite, as was evidenced by the company’s 33% percent increase in its dividend from 6 cents per month to 8 cents per month.
The company’s gold equivalent production rose by 17.5 percent, which is incredible growth for a company as conservative as Franco Nevada (the company has $860 million in working capital, most of which is in cash and equivalents, and no debt). Gold production attributable to Franco Nevada reached nearly 70,000 ounces for the quarter and exceeded 240,000 ounces for the year.
Note that given Franco Nevada’s business model of buying royalties on gold mines that most of this gold comes without any cost to the company. This means that even with a depressed gold price, the company generated $400 million in revenues, much of which goes directly to the bottom line after taxes The company’s EBIDA came in at $322 million and its adjusted net income (excluding the two aforementioned write-downs) was $138 million.
Furthermore, Franco Nevada has been very aggressive in purchasing additional streaming deals from mining companies in need of capital in a depressed gold price environment. Some of these deals include:
- The purchase of a 2 percent royalty on Yamana Gold’s (NYSE:AUY) Cerro Morro project in Argentina.
- The purchase of a royalty on Klondex Mines’ (OTC:KLNDF) Fire Creek and Midas mines in Nevada amounting to 38,250 ounces of gold in the next six years followed by a 2.5 percent royalty on the two mines’ remaining production.
- The purchase of a gold stream on Teranga Gold’s (OTC:TGCDF) Sabodala mine in Senegal that entitles Franco Nevada to purchase 6 percent of this mine’s gold production at 20 percent of the price of gold.
These deals all have a lot of potential to generate revenues and profits that greatly exceed Franco Nevada’s initial investment while providing capital to companies that need it in order to develop and expand their mines.
Gold equivalent production is going to be roughly flat in 2014, although over the next few years it is expected to rise to over 300,000 ounces annually. This figure can be significantly higher if production increases at any of the mines on which Franco Nevada owns royalties and streams.
Ultimately, given the company’s $7.35 billion valuation, the stock is overvalued given its cash flow potential. Gold bulls have bid this company’s shares up given management’s past success of funding large projects in their infancy and generating enormous returns in the hundreds of millions from initial investments of just a few million.
Investors are also attracted to the company’s appealing business model: The company’s costs are relatively stable and well below the gold price. Deals such as the one made with Teranga Gold entitling it to purchase 6 percent of the gold produced at Sabodala at 20 percent of the gold price ensure that the company’s costs remain well below the gold price.
However, I think that Franco Nevada’s valuation may be catching up with it. The company’s major peer – Royal Gold (NASDAQ:RGLD) — trades at a more reasonable valuation despite the fact that it takes on an little more risk, although so far this year to date, Royal Gold shares are up almost 50 percent whereas Franco Nevada shares are up just 17 percent. Investors concerned about Franco Nevada’s valuation will be pleased to learn that a pullback seems to be underway.
While the shares will almost certainly trade at a lofty valuation given the quality of Franco Nevada’s business, there will be opportunities to get involved, and the most recent earnings report indicates that buying this stock on weakness is a wise decision for risk-averse gold bulls.
Disclosure: Ben Kramer-Miller is long Yamana Gold, Royal Gold, and Klondex Mines.